macro: David Laidler’s “New” Misdirected Investment Boom & Bust Mechanism

A “enhanced expectations” model of misdirected investment can be found already in F. A. Hayek’s Monetary Theory and the Trade Cycle — see Lecture IV were Hayek talks of an unsustainable boom sparked by enhanced profit expectations — but David Laidler puts some very contemporary bones on it in his paper “Financial Stability, Monetarism and the Wicksell Connection”:

The cyclical behaviour of expenditure on capital goods, however, has long been known to be every bit as distinctive as those of money, output and prices, and it invites explanation not to satisfy scientific curiosity, but also, if the insights associated with the Wicksell connection are correct, because of its particular relevance to the inter-temporal coordination failures that they highlight as undermining financial, not to mention real, stability. Extending the standard model to accommodate these factors presents a challenge that is more daunting than the re-integration an active role for monetary and financial aggregates into its account of policy’s transmission mechanism. And this task is not made easier by the need for disaggregation implicit in Robertson’s surely correct observations about the tendency of forced saving and its consequences to be concentrated in any particular instance on specific sectors of the real economy rather than to spread right across it.  Presumably over-investment fed by forced saving can get under way in a particular sector either because some technological improvement gives rise to enhanced expectations about the real returns to be earned from investing there that then get out of hand, or because the introduction of some new method of channeling credit into it creates profit opportunities whose true magnitude might be just as easy to over-estimate.   The former type of shock has, of course been much analyzed, and in recent experience seems to be what drove the dot-com bubble. The latter is worth more attention, for it was surely new techniques for financing mergers and acquisition that underlay the stock market boom and bust of 1987, and new kinds of mortgages not to mention methods of securitizing them that created the recent US housing bubble. These considerations in turn suggest that localized innovations both in production itself and in the technology of financial transactions need to be modeled as possible sources of disequilibrating shocks to the financial system as a whole. Though the financial accelerator mechanisms that are nowadays attracting so much attention, with their emphasis on the effects on credit creation of variations in the value of particular assets as collateral, are surely adaptable to such a task, it is nevertheless one that is more easily proposed than accomplished.15

15 I am indebted to Bill Robson for the suggestion that financial innovations themselves might be a source of relative price distortions that can in turn create forced saving, and to Pierre St-Amant for drawing my attention to the relevance of financial accelerator analysis in this context.

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One Response to macro: David Laidler’s “New” Misdirected Investment Boom & Bust Mechanism

  1. Usdating says:

    Nice piece of text I must say. Is it oke for me to make a translation in Dutch with a obvious link to this article?

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